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Motor company forced to do U-turn in landmark dividend decision

Posted: 15/05/2020

Shareholders in FTSE 250 company TI Fluid Systems yesterday voted down the company’s proposal to pay a £27 million dividend. In a highly unusual move, 57 per cent of shareholders in the motor part manufacturer used their votes to block the dividend payment which had been recommended by the board just four days earlier. It followed critical media coverage of the proposal, which centred on the fact that the company was making the payment while furloughing staff and cutting workers’ pay and would have resulted in a payment of almost £15 million to US private equity firm Bain Capital. Bain, which owns 54 per cent of the company, initially supported payment of the dividend, but subsequently reconsidered the position and voted against payment.

The vote provides a clear sign of the extraordinary times through which we are living – shareholders blocking the payment of a dividend to them by a board which had concluded that the company’s first quarter ‘performance and overall liquidity and financial position’ supported payment of the 2019 final dividend. It also provides a snapshot of the decisions which will be facing companies large and small across the country.

The legal position

Legally, a company may only pay a dividend out of distributable reserves, ie realised profits which have been allocated for the payment of the dividend. Directors of a company proposing to make a dividend payment must carefully consider their duties as directors and the solvency of the company. This is particularly the case given the current situation where many previously thriving businesses now face declining revenues, a weakening balance sheet and/or uncertainty as to resumption of trade.

Where a business is insolvent or even when it is of doubtful solvency, its directors have a duty to consider the creditors’ interests (including its furloughed employees) above the interests of its members. Under section 123 of the Insolvency Act 1986 (1986 Act), a business will be considered insolvent by application of one or both tests for insolvency, known as the 'cash flow' test and the 'balance sheet’ test. The cash flow test is where the business is unable to pay its debts as they fall due. The balance sheet test  is where it is proven to the satisfaction of the court that the value of the business' assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

The current reality is that for many companies at least one of these tests may have been triggered. The duties and potential liabilities upon a director under the 1986 Act are widely construed and apply equally to de facto or shadow directors (ie an unappointed individual/connected business whose instructions the directors are accustomed to follow). A director who is party to payment of an unlawful distribution could be liable for misfeasance under section 212 of the 1986 Act which provides for a remedy against directors who have misapplied, retained, become liable or accountable for any money or property of the business, or have been guilty of misfeasance, breach of fiduciary duty or any other duty in relation to the business. As such, it covers a wide variety of wrongs including the improper payment of dividends. A director found guilty of misfeasance would likely be ordered to repay or restore the money or the property with interest or to contribute money to the assets of the business by way of compensation.

A number of official bodies have provided guidance relating to dividend payments for directors. For example, the Financial Reporting Council (FRC) published guidance which recommended that the assessment of whether a dividend is appropriate should include consideration of current and likely operational and capital needs of the company, its contingency planning and the directors’ legal duties. It stated that a company’s directors should ensure that the capital maintenance rules of Part 23 of the Companies Act 2006 (CA 2006) are complied with, that they fulfil their duties under CA 2006, s 172 and that due consideration is given to their fiduciary duties to ensure the company will be able to pay its debts as they fall due.

Similarly, the Investment Association (IA) recently wrote to the chairs of all FTSE 350 companies. IA members support the FRC guidance (above) stating that companies should reconsider the suitability and sustainability of dividend payments in light of the current uncertainties. Companies’ approach to paying a dividend should include ensuring employees and suppliers can be paid.

That prudent approach must of course be balanced with the fact that dividends remain an important income stream for employees, savers, pension funds and charities. The IA stated it would expect companies who do decide to suspend, to restart the dividend payments as soon as it is prudent to do so.

There will be exceptional companies which are thriving during this period and feel able to make the dividend payments. But for many (we anticipate most), prudence will be the watchword. Even for those companies able to pay a dividend, the risk remains (as with TI Fluid Systems) that the move attracts adverse publicity. Each case will of course turn on its facts: we are at hand to advise if and when guidance is required on this testing question.

Points to consider:

  • Now more than ever directors need to think very carefully about whether a dividend payment is currently appropriate or can properly be deferred.
  • Directors party to the payment of an unlawful dividend during these Covid-19 times could be liable for misfeasance and/or breach of fiduciary duty, with the real possibility of unlimited personal financial exposure (with D&O insurance policies ordinarily not responding to deliberate recklessness).
  • As such it is vital that board decisions are properly recorded and that company procedure is complied with. In current circumstances, many directors should seek specialist legal and accountancy advice before recommending a dividend payment. Given the potential reputational damage, companies should also prioritise clear communication regarding any such decisions to pay, defer or cancel the dividend.

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Penningtons Manches Cooper LLP